Allegro Wireless Canada Inc. v. The Queen: Expert Witnesses and SR&ED
*** This information is presented for educational purposes only and does not constitute legal advice. You should retain legal counsel if you require legal advice regarding your individual tax situation. ***Â
On March 31, 2021, the Tax Court of Canada (TCC) delivered a ruling on a Scientific Research & Experimental Development (SR&ED) investment tax credit (ITC) claim. In the case of Allegro Wireless Canada Inc. v. The Queen (2021), Justice Steven K. D’Arcy allowed the appeals with a reassessment of expenditures and corresponding ITCs, stating that the Appellant had clear and well-documented evidence of the hypotheses posed, the work performed, the system uncertainties encountered, and the technological advancements found.
This article will take a closer look at this case to provide the following:
- An overview of the case against Allegro Wireless Canada Inc. (“Appellant”)
- Key arguments & lessons learned from Justice D’Arcy’s ruling
Allegro Wireless Canada Inc. v. The Queen: An Overview
Allegro Wireless, the Appellant, is a software development company. In 2010 and 2011 they submitted SR&ED investment tax credit (ITC) claims. In the 2010 tax year, Allegro claimed SR&ED expenditures of $798,342 and corresponding ITCs of $279,420 in respect of three projects. The CRA disallowed $697,723 of the amount claimed as SR&ED and $244,208 of the corresponding ITCs in respect of two projects. In the 2011 tax year, Allegro claimed SR&ED expenditures of $615,906 and corresponding ITCs of $215,567. The CRA disallowed $463,401 of the amount claimed as SR&ED and $162,190 of the corresponding ITCs. Allegro developed software that tied various other software systems together, the source code was often not available and system uncertainty was present. Allegro used Jira X to track their work and SR&ED eligible work. In the 2010 tax year, the CRA accepted Project 3 as filed and in the 2011 tax year, the CRA accepted Project 2 as filed. The CRA split the projects up based on their technological objectives. Five projects filed by the Appellant turned into seven technological advancement/technological obstacles evaluated for eligibility by the CRA. It is unclear as to why the CRA evaluated each technological advancement separately as opposed to the project as a whole. The Appellant’s CRA scientific research and technology advisor, Mr. Wong, assisted in setting up the tracking software for the project.
First, the Respondent questioned the report presented by the expert witness for the Appellant, Dr. Penn. The judge cited White Burgess Langille Inman v. Abbott and Haliburton Co., 2015 SCC 23, and their use of a two-step test to determine the admissibility of an expert witness. The judge held a voir dire to determine the admissibility of Dr. Penn’s expert opinion evidence. The judge ruled that Dr. Penn was a qualified witness who had the requisite special knowledge and experience relating to the specific subject matter on which he was being offered. The Respondent did not question the credentials of Dr. Penn but rather his reference of Mr. Wong’s, the Appellant’s CRA scientific research and technology advisor, technical review of the Appellant’s projects. The judge ruled that Dr. Penn’s comments stood on their own apart from Mr. Wong’s and it was necessary to reference Mr. Wong’s reports to draw his conclusions. The Respondent also was concerned about Dr. Penn’s phone interviews with employees of the Appellants. While there are no transcripts of these conversations, Dr. Penn produced handwritten notes for each interview. The judge ruled, “the factual foundation for Doctor Penn’s testimony was proven by the admissible evidence before the Court.”
While the two expert witnesses provided by the Respondent were deemed to be qualified in their fields by the judge, the factual foundation of their reports was ruled to be based on insufficient information. The judge ruled neither “had a sufficient understanding of the Appellant’s business, products or procedures that would allow them to give opinions that would help the Court.” The judge also stated:
After reading Doctor Ali’s and Doctor Keshav’s reports and hearing their oral testimony, I have concluded that neither had the required understanding of the Appellant’s business. In my view, this represents a fatal flaw in their reports. They did not have the necessary factual foundation that would allow them to provide to the Court informed opinions on the projects in question.1
The expert witnesses of the Respondent were not aware of the software (FogBugz and Jira X) used to track the SR&ED eligible work including hypotheses, work performed, and documentation. The Respondent’s expert witnesses did not inquire about additional information aside from the T661 when making their conclusions and reports.
The judge used the five questions of eligibility from Northwest Hydraulic and CW Agencies to determine if the projects in question constituted SR&ED. Additionally, the judge used the opinion of the Appellant’s expert witness to confirm his rulings. The judge ruled, “With respect to projects TA1/TO1 of 2010 Project 1, TA1/TO1 of 2010 Project 2 and TA1/TO1 of 2011 Project 1, I agree with the Appellant and Doctor Penn that the work done by the Appellant was experimental development.” The judge also stated that the technological uncertainties would not exist today because of the advancements made over the last ten years but they did exist in 2010 and 2011. The judge also ruled:
On the basis of the evidence before me, particularly Mr. Rupel’s description of the research the Appellant performed and Doctor Penn’s expert opinion, I have concluded that the work undertaken by the Appellant with respect to projects TA1/TO1 of 2010 Project 1, TA1/TO1 of 2010 Project 2 and TA1/TO1 of 2011 Project 1 related to the development or improvement of its product and involved attempting to resolve a technological risk or uncertainty that could not be resolved by routine engineering or standard procedure.2
The judge also ruled that while part of 2010 Project 2 (TA3/TO3) may not be SR&ED on its own, it supported the other overall objective of the project. 2010 Project 2 was ruled to be SR&ED. Additionally, the judge ruled:
On the basis of the evidence just discussed, I have concluded that when the Appellant conducted the projects at issue, it formulated hypotheses specifically aimed at reducing the identified technological uncertainty, followed appropriate procedures on testing, including the formulation, testing, and modification of hypotheses, and maintained a detailed record of the hypotheses tested and results achieved as the work progressed.
For these reasons, the work performed by the Appellant on the projects identified by the CRA as TA1/TO1 of 2010 Project 1, TA1/TO1 of 2010 Project 2, TA3/TO3 of 2010 Project 1 and TA1/TO1 of 2011 Project 1 constitutes SR&ED for purposes of the Income Tax Act.3
After determining that the work conducted was SR&ED eligible, the judge then examined the SR&ED eligible expenditures and investment tax credits (ITCs). Despite repeated requests, neither party submitted information on these items. For the 2010 taxation year, the Appellant filed $587,005 of eligible SR&ED expenditures comprising of $25,000 in contractor costs and $562,005 in salary and wages. The CRA only allowed $171,979 in salary costs. The Appellant did not provide any documentation or support for the contractor costs and the judge ruled these to be ineligible per the Assistance and Contracts Payments Policy. The judge allowed $425,911 in salary and wages for 2010 for TA1/TO1 of 2010 Project 1, TA1/TO1 of 2010 Project 2 and TA3/TO3 of 2010 Project 2. For the 2011 taxation year, the Appellant filed $418,890 in salary and wages but the CRA allowed $120,635. The judge ruled that $355,891 was eligible salary and wages. The prescribed proxy amount was adjusted based on the new salary base.
The judge also examined the government funding claimed and assessed for the taxation years. The first type of government assistance received was an IRAP grant for each taxation year. The Appellant deducted $65,261 in the 2010 taxation year and $6,829 in the 2011 taxation year in respect of the IRAP Grant. No evidence was provided to account for how the Appellant came to these calculations. For the 2010 taxation year, the CRA calculated how many hours each employee worked on SR&ED eligible projects and which projects received IRAP grants to calculate how much of the IRAP grant should be deducted. The CRA deducted 131,054 in respect of the projects it accepted as SR&ED. In the 2011 taxation year, the CRA deducted the entire IRAP Grant of $131,054 when determining the Appellants SR&ED eligible expenditures but it deducted the entire $171,979 of salary and wages it had deemed eligible when calculating the corresponding ITC. The judge ruled that the CRA incorrectly calculated the IRAP expenditures in the 2011 taxation year and the same number is used to determine which part of the IRAP grant was in respect of SR&ED, $131,054, should have been used in both sections. The judge stated, “When a taxpayer is calculating its ITC, this paragraph requires the taxpayer to deduct the amount of government assistance received. It is required to deduct the government assistance if it can reasonably be considered to be in respect of SR&ED.” The judge determined that for the projects that the Court has found to be SR&ED results in an IRAP Grant of $202,889 in the 2010 taxation year and $22,386 for the 2011 taxation year. The second part of government assistance was the Ontario Innovation Tax Credit (OITC). This is a provincial tax credit and is based on eligible salaries and wages, contract expenditures, PPA, and government assistance like the federal SR&ED ITC.
Based on the judges ruling the qualifying SR&ED expenditures for the 2010 taxation year were $449,878 and SR&ED ITCs for the 2010 taxation were $157,457; for the 2011 taxation year the qualifying SR&ED expenditures were $508,351 and SR&ED ITCs were $177,923. The appeals were allowed with costs and the reassessments were referred back to the Minister for reassessment.
Justice D’Arcy’s Ruling: Key Arguments & Lessons Learned for Expert Witnesses and SR&ED
There are a few key takeaways that stand out regarding software and SR&ED.
- Expert Witnesses: The Appellant provided one expert witness during this legal ruling and the Respondent provided two. The Respondent’s experts’ reports were deemed by Judge D’Arcy to be based on insufficient information and were given no weight, as neither had a full understanding of the Appellant’s business and relied solely on the T661s; neither looked at the documentation the Appellant had provided. A full understanding of all the evidence and the context of the work performed is essential in order to provide true expert witness reports. The expert witness reports may sway the judge in their final rulings and can make or break the case.
- Contemporaneous Documentation: The Appellant was able to prove the eligibility of their SR&ED claim through the documentation they stored within the Jira X software. The work they performed was thorough and complete as question 5 of the Five Questions of Eligibility in Northwest Hydraulics Consultants Ltd. v. The Queen (1998) states it must be. Maintaining a well-organized and thorough collection of documentation, both technical and financial, is essential for the success of SR&ED applications, both for eligibility of work and expenditures/time spent of SR&ED. Please consult our article Useful Tools for SR&ED Documentation and the T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim to see the forms of documentation which the CRA will accept should they need to review your claim.
- Research and Technology Advisor (RTA) Guidance: In this case, the RTA, Mr. Wong, helped the Appellant set up their Jira X bug tracking software and provided a report on his opinion of what work was indeed eligible as SR&ED. The Appellants projects, in this case, were initially appealed, however, Mr. Wong’s report was used by the expert witnesses to form their reports. The assistance of a CRA RTA does not guarantee the successful filing of your SR&ED project but can be useful as evidence in the case of an appeal.
As inadequate documentation may lead to a denied claim and lost money it is critical to keep your supporting documentation organized and complete. This will help to validate your claim that the work performed is indeed SR&ED eligible and to substantiate the SR&ED expenditures and time spent. It is therefore important that if you received CRA support you have the RTA’s report on hand to allow for a thorough examination by the judge and expert witness(s). Expert witness reports provide excellent arguments for the judge to consider and can be the difference between winning or losing the case. It is not common to have the judge dismiss an expert witness as occurred in this case, and it is crucial all those involved in the legal proceedings are able to obtain the full knowledge of the project(s) in question.Â
To view the ruling in its entirety please see Allegro Wireless Canada Inc. v. The Queen (2021).